Why History is Doomed to Repeat Itself (and why it's okay)

November 23, 2015

I was recently discussing retirement planning and different ways to save with an individual over dinner when he brought up an investment opportunity that he was considering.  He described it as a fund that had a fancy algorithm that would allow him to sell out of the market at market tops and yet somehow resume growing once the market had recovered, effectively allowing him to skip the downturns.  At this point, I’m sure you’re thinking “Sign me up!  That sounds like the greatest investment idea ever!”  And you’re right.  It is.  But it also doesn’t exist.  What my friend was describing was an algorithm that could predict the future, and if such an algorithm existed, it would break the financial markets.  It is only possible to see market highs in hindsight because only after the market has fallen does a certain point become a high.  It’s impossible to tell whether the market is going to continue going up or down at any given point; however, there is something that we can be certain of and, in doing so, make smart decisions to prepare for the future and that is the cyclical nature of the capital markets.


How can I be so sure that the markets are cyclical?  Great question.  Let’s consider our current position in the market as a starting place.  As you probably know, the last several years have been pretty great.  We’ve had a few hiccups, but for the most part, we’ve experienced some pretty impressive growth.  It all started after the market crashed in 2008 when everything suddenly became very cheap.  Because everything was cheap, investors slowly began investing again (who doesn't want to buy something at a great discount?).  As their trust in the markets was restored, more money flooded in, pushing up prices.  Those returns looked good, inspiring more trust and bringing in more money.  Investors have since become less fearful and resumed taking on leverage.  In the past, this increased inflow of cash created plump companies who, having run out of high-returning projects to invest in, began to invest in average to low-returning projects.  As their investments played out and the lower-returning ones began to sour, investors begin to get skittish for fear that their investments may not continue generating the same high returns that they had been experiencing.  They then began pulling their money back out, pushing the price down, causing others to pull their money out and so on and so forth until the company was once again lean at which point the price to invest in them became cheap.  Thus we find ourselves at the start of yet another cycle.  We’ve seen this process over and over again, to varying degrees in the past and we are likely to continue to see it play out in the future.


What then are the implications of the cyclical nature of the markets?  In my mind, there are several takeaways.  One is that while we can’t predict the future, we can prepare for likely outcomes.  If markets are in fact cyclical, then it should be much easier to hold on during inevitable downturns because we are conscious of inevitable recoveries.  Additionally, cycles keep markets healthy by trimming down plump companies and reallocating capital to sources of potential growth.  This means that cycles offer opportunities that can be exploited by those who are willing to rebalance into the “trimming” process in order to take advantage of the phase in the cycle where assets are cheap.


If you’d like to learn more about cyclicality or would simply like to speak with an advisor on the best way to invest for long-term success, please don’t hesitate to reach out.  We’re always happy to chat.

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